What’s the bank rate?

The bank rate, also often referred to as the discount rate, is the interest rate at which a country’s central bank loans commercial banks money. There were way too many “rates” flying around in that last sentence, so in the interest of clarity, we’ll back up a bit.

Banks are federally mandated to hold a certain percentage of their deposits on hand in cash at all times — one of the reasons you never see bank runs anymore; if it came down to it, banks would actually be able to pay all their depositors what they owe them. But sometimes banks run low on cash, and to avoid running afoul of the law they need to get some extra dollars on the books. To do this, they borrow money. Normally, they’ll borrow surplus reserves from other banks that have a little more than they’re required to have on hand. The interest rate the Fed allows banks to charge one another is called the overnight rate, or the federal funds target rate. (When you hear that the Fed is considering raising or lowering interest rates, this is the rate people are talking about.)

But there are also rare situations when the Fed may lend money directly to banks that are having trouble procuring the reserve requirement through the normal bank-to-bank overnight lending channels. Though there are some less-than-dire reasons for this, it’s a situation often associated with traumatic economic events, like the September 11 terrorist attacks, or the 2008 financial crisis. As a disincentive for banks to borrow money from them rather than other banks, the Fed will set their interest rate higher than it will set the overnight rate. The interest rate the Fed will charge is called the bank rate, or discount rate.

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